Case Study : Capitalism This case views the global, capitalist economic system through the prism of the 2007-2008 financial crisis (referred to here as the Financial Crisis). More than a decade later, what more do we now know? How did the crisis emerge, and what were its consequences (short- and long-term)? What challenges does it present for capitalism today? What was the role of social responsibility? And perhaps most importantly, what changes does a strategic CSR perspective suggest moving forward? The Financial Crisis In many ways, the dramatic economic events that began toward the end of 20071 (widely reported as "the most serious financial crisis since the Great Crash of 1929"2 or the "Great Recession"3) brought into focus the comprehensive nature of CSR. From individual greed and the abdication of responsibility, to organizational fraud and the mismanagement of resources, to governmental failure to monitor and adequately regulate the financial system, the crisis emphasized the many interlocking factors that make CSR so complex. At the same time, and with the benefit of hindsight, these events demonstrate how straightforward CSR can be. At its simplest, CSR is not rocket science. It is often common sense, combined with an enlightened approach to management and decision making. To look back at some of the decisions that contributed to the economic crisis and try to rationalize why they were made, however, represents an exercise in exasperation: What do you call giving a worker who makes only $14,000 a year a nothing-down and nothing-to-pay-for-two-years mortgage to buy a $750,000 home, and then bundling that mortgage with 100 others into bondswhich Moody's or Standard & Poor's rate[s] AAAand then selling them to banks and pension funds the world over?4 Essentially, the crisis resulted from the cumulative effects of multiple bad decisions by many individuals who had lost their sense of perspective.5 What was amazing at the time was "how so many people could be so stupid...and self-destructive all at once"6 to produce "a near total breakdown of responsibility at every link in our financial chain."7 The scale of negligence and culpability defies belief:8 How could the people who sold these [products] have been so short-sightedly greedy?...How could the people who bought them have been so foolish?9 At the height of the boom, the subprime mortgage industry in the United States had clearly lost all sense of proportion. The result was higher default rates and, as a consequence, higher rates of home repossessions: Between 2005 and 2007, which was the peak of sub-prime lending, the top 25 subprime originators made almost $1,000bn in loans to more than 5m borrowers, many of whom have [since] had their homes repossessed.10 The industry as a whole experienced all the signs of a bubble, the aftermath of which generated dramatic headlines such as "Sex, Lies, and Mortgage Deals."11 As a society, we should have picked this up earlier and acted to diffuse it. As such, the Financial Crisis highlights the central role of CSR in today's global business environment. It is a lens through which excesses can be minimized, risk can be mitigated, and value can be optimized. At various stages, key actors suspected the system was unsustainable, but had no self-interest in advocating for change. As Citibank's Chuck Prince said in 2007, shortly before the crash and his ouster as CEO later that year, "as long as the music is playing, you've got to get up and dance. We're still dancing."12 When firms lack a CSR perspective, they not only endanger themselves but also can cause great harm to society. Moral Hazard The Financial Crisis was driven by three main factors: first, the housing market bubble, which was fueled by low interest rates and easy access to mortgages (e.g., so-called "liar"13 or "ninja"14 loans); second, the underpricing of risk, particularly by investors on Wall Street; and third, the failure (or inability) of the regulatory infrastructure to police the increasingly liquid global financial market. In other words, there is plenty of blame to go aroundfrom the individuals who sold mortgages that had attractive commissions but were unlikely to be repaid, to the firms that allowed these sales to continue because they were passing on the risk, to the regulators who failed to oversee the markets it was their responsibility to monitor, to the investors who developed complex securities and other financial instruments that few people (including themselves) fully understood. This culpability extends to the people who failed to question whether it was wise to apply for 100 percent mortgages on hugely inflated home prices with little or nothing down, purely on the belief that house prices would continue to rise, and the confidence that, either way, they would be able to refinance in a couple of years. All of these decisions were made in an atmosphere of overdependence on the market as the ultimate arbiter that relieved individual actors of personal responsibility for many of their day-to-day decisions. This faith in the market was misplaced because of its underlying rules, which distorted the dynamic interplay of demand and supply. This structure, put in place over decades by biased or ill-informed politicians (who passed hastily constructed regulations) and shortsighted executives (who were only too willing to forget any lessons learned from previous recessions) enabled the crisis and inflamed it once it had started. In essence, moral hazard was rifethe finance industry was essentially rigged to fail. Over time, a system of incentives had been put in place whereby the rewards to business were privatized (accrued directly to individuals), while the risk was socialized (borne by the system through financial institutions that were deemed too big and important to fail); this represents, according to George Soros, the failure of a pure market ideology: [Market] fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves.15 Western governments and businesses have essentially created an unsustainable system.16 As Soros notes, in order to avoid the damage to the broader economy that would result from undermining the positions of global financial traders, governments and central banks averted their eyes from the moral hazard that is an inherent part of the financial system. The result was "a system of asymmetric incentives" backed by a federal agreement that "every time the credit expansion ran into trouble the financial authorities intervened, injecting liquidity and finding other ways to stimulate the economy."17 Martin Wolf in the Financial Times paints a picture of equally complicated interacting causes that include a "fundamentally defective financial system," "rational responses to incentives," "the short-sightedness of human beings," overly loose US monetary policy, and "the massive flows of surplus capital" around the globe.18 He highlights the role of governments in sustaining a system that has become too important to the economy. In essence, everyone knows the large financial firms are too big to fail, yet everyone with sufficient power to nothing about it is OK with that: Those who emphasise rationality can readily point to the incentives for the financial sector to take undue risk. This is the result of the interaction of "asymmetric information"the fact that insiders know more than anybody else what is going onwith "moral hazard"the perception that the government will rescue financial institutions if enough of them fall into difficulty at the same time. There is evident truth in both propositions: if, for example, the UK government feels obliged to rescue a modest-sized mortgage bank, such as Northern Rock, moral hazard is rife.19 Global Capitalism While the crisis was inherently the creation of the US financial markets and regulators, for it to have the global reach it did required the buy-in of the rest of the world. Everyone was happy to play along while the market was going up. The resulting backlash against the status quo following the crash, therefore, represents a challenge to the spread of globalization shaped largely by US liberal capitalism (e.g., deregulation, free international money flows, self-correcting markets, and the efficient pursuit of profit in the form of shareholder returns): This suspicion of Anglo-Saxon economic liberalism cut across the usual political boundaries. Right-wing industrialists disliked it, but so did left-wing labor unions. Chinese communists felt threatened, but so did Green Party activists in Germany....The critique of U.S. liberalism...is shared by a diverse group that includes French President Nicolas Sarkozy, German Chancellor Angela Merkel, Chinese Prime Minister Wen Jibao and Russian President Dmitry Medvedev.20 This backlash began more than a decade ago, in the immediate aftermath of the Financial Crisis, but continues to resonate today. What is not clear, ultimately, is how effective or self-sustaining this critique will be and whether, in conjunction with any shift in economic ideology, there will be a corresponding shift in global political power. The dominant feature of the US economic model prior to the crisis was an inherently unstable combination of excessively low savings and excessively high borrowing. This surplus of credit was being used to finance an unsustainable level of consumptionunsustainable because the United States was consistently spending more than it saved. That money had to come from somewhere, and most of it came from China. As such, the only real, long-term solution to the crisis is a rebalancing of demand and supply within the global economy,21 which represents a shift in influence from the borrower to the lender: [The crisis] is not only a crisis of capitalism or of a particular form of capitalism after all; it's one of U.S. economic and global power....The fact that [the meeting to discuss a global response is] of the G-20 rather than the Group of Seven...is a symbol of the decline of U.S. economic power exposed by the crisis.22 The sense was that things had changed and US capitalism, as the driving force behind globalization, is slowly losing its ability to shape the world: Even a newspaper as inherently pro-business as [The Economist] has to admit that there was something rotten in finance. The basic capitalist bargain, under which genuine risktakers are allowed to garner huge rewards, seems a poor one if taxpayers are landed with a huge bill for it.23 The debate that has emerged within the CSR community regarding the future shape of capitalism reflects this shift in the content and tone of discussions about the global economic system. Thomas Friedman in The New York Times, for example, highlights the intersection of the economic and environmental crises: What if the crisis of 2008 represents something much more fundamental than a deep recession? What if it's telling us that the whole growth model we created over the last 50 years is simply unsustainable economically and ecologically and that 2008 was when we hit the wallwhen Mother Nature and the market both said: "No more"?24 In early 2009, articles with titles such as "Is Capitalism Working?"25 and "The End of the Financial World as We Know It"26 began to appear in respected outlets. This sense of seismic change was reinforced by a series of articles in the Financial Times about the crisis and its consequences for the economic order. The goal of the series, which was titled the "Future of Capitalism," was to assess the consequences of the crisis, given that the "assumptions that prevailed since the 1980s embrace of the market now lie in shreds." Representative of the debate was this comment in the opening article in the series: It is impossible at such a turning point to know where we are going....Yet the combination of a financial collapse with a huge recession, if not something worse, will surely change the world. The legitimacy of the market will weaken. The credibility of the US will be damaged. The authority of China will rise. Globalisation itself may founder.27 Combined with Bill Gates's call for "creative capitalism"28 (2008) and Muhammad Yunus's book Creating a World Without Poverty29 (2009), the sense at the time was of a point of "inflection"30 in the economic history of our planet. While we might not have expected measurable change immediately, the intellectual shift indicated that whatever shape globalization took going forward, it would be different than it was before the crisis.31 Occupy Wall Street The resulting economic reality led initially to various forms of protest, most notably the Occupy Wall Street movement (http://occupywallst.org/), which initially started with a tweet by Adbusters (#occupywallstreet).32 It took root in Zuccotti Park in Lower Manhattan, but soon spread worldwide. The failure of this movement to organize and sustain its momentum does not diminish the power of the ideas on which it was founded. An important indicator of change, therefore, will be whether the intellectual driving force behind Occupy Wall Street that challenged the legitimacy of the efficient market can ever be corralled into a meaningful platform for reform. Along these lines, the evolving thoughts of Alan Greenspan, chair of the US Federal Reserve from 1987 to 2006, on the self-policing role of market forces is instructive. In 1963, Greenspan wrote that it would be self-defeating (and, therefore, highly unlikely) for firms "to sell unsafe food and drugs, fraudulent securities, and shoddy buildings. It is in the self-interest of every businessman to have a reputation for honest dealings and a quality product." By 2008, in testimony to the House Committee on Oversight and Government Reform, however, Greenspan admitted the error in this line of thought: Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief....This modern [free market] paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year.33 Greenspan's shift demonstrates the limits of the unregulated market (the "efficient market hypothesis")34 in the face of incentives that significantly distort the checks and balances that are theoretically in place. As summarized in a Financial Times editorial, "the intellectual impact of the crisis has already been colossal. The 'Greenspanist' doctrine in monetary policy is in retreat....Finance has already changed irrevocably."35 The extent of public anger toward the finance industry was demonstrated over time in regulatory action intended to hold banks to account for their wrongdoing. While very few individuals were ever indicted (let alone sent to jail)36 for their roles in the Financial Crisis, the firms they worked for were penalized heavily: The six biggest U.S. banks, led by JPMorgan Chase & Co. (JPM) and Bank of America Corp., have piled up $103 billion in legal costs since the financial crisis, more than all dividends paid to shareholders in the past five years. That's the amount allotted to lawyers and litigation, as well as for settling claims about shoddy mortgages and foreclosures, according to data compiled by Bloomberg. The sum, equivalent to spending $51 million a day, is enough to erase everything the banks earned for 2012.37 While the legal costs associated with the Financial Crisis for the world's sixteen largest banks have been estimated to top 200 billion (perhaps hitting $306 billion),38 Figure II.1 illustrates the extent of the fines paid by the six largest US banks. In the end, "JPMorgan and Bank of America bore about 75 percent of the total costs."39 In Bank of America's case, much of this total is attributed to its purchase of Countrywidea decision that "'turned out to be the worst decision we ever made,' said one Bank of America director who had voted for the Countrywide deal."40 In total, since 2008, the bank "has paid monetary and non-monetary fines and penalties of more than $91 billion...in some 51 settlements, including a record $16.65 billion to the Justice Department and several states."41 As an indication of its further fall from grace, in 2013 the bank was removed from the Dow Jones Industrial Average index, along with Alcoa and Hewlett-Packard, to be replaced by Goldman Sachs, Visa, and Nike.42 As such, the Financial Crisis refocused the debate on the personal ethics of decision makers and the wisdom of fostering leaders willing to make the best decisions in the long-term interests of their organizations and stakeholders. Together with the debate about the implications of the crisis for the global political power balance and the form of capitalism that will drive globalization forward, the crisis injects an element of urgency to achieving cross-cultural understanding in a complex global business environment, where decisions taken by firms in one country have implications that can reverberate around the world. In particular, this crisis crystallizes a number of questions that highlight the importance of CSR: What does it mean for society when widespread business failure results in broad social and economic harm? How will this affect the environment in which subsequent generations seek jobs and launch the firms of the future? How will societal expectations of these firms change (if at all), and how should the business community respond? And essentially, what obligations do we have as individuals, organizations, governments, or societies to avert similar crises in the future? Figure II.1 Fines Paid by US Banks (2010-2013) Source: Saabira Chaudhuri, "U.S. Banks' Legal Tab Is Poised to Rise," The Wall Street Journal, October 28, 2013, http://www.wsj.com/articles/SB10001424052702304470504579163810113326856/. The Financial CrisisTen Years On When Lehman Brothers filed for bankruptcy protection in September 2008, "it was the biggest bankruptcy filing in history10 times the failure of the fraud-riddled energy company Enron." The collapse led to the firm's 25,000 employees losing their jobs and the demise of "the oldest and fourth largest US investment bank"; it also "sparked the global financial crisis."43 In the decade since, following that "moment when everything changed,"44 we have had some time to reflect: Prior to Lehman, it was easy to believe that housing prices could only go up and that we could always rely on debt to maintain our standard of living. We shrugged as manufacturing jobs disappeared...and good middle-class jobs became harder to find. We didn't talk much about income inequality. Nor did we care much that Wall Street had developed a mercenary trading culture, which had little to do with providing capital for companies, ostensibly its reason for being. Post-Lehman, economic reality set in.45 Ten years after the end of the Financial Crisis, while those most closely involved in the decisions taken at the time seek to reassure us that the response was a success,46 others argue that little has changed: Oversight and disclosure have been improved and capital-adequacy rules toughened. But some of these rules are now being relaxed, at least in America, and the financial industry's weight in the world economy has scarcely changed. As a share of American GDP it has actually increased somewhat since 2007.47 As a result, banking is still a very lucrative profession for those who choose it,48 with high rewards and little accountability: The finance sector, which caused the crisis, looks remarkably unaltered. Banks may now hold more capital and their bonuses are now tied to longer-term performance. But bonuses are still very high; the average payout on Wall Street [in 2017] was $184,220, just shy of the 2006 record. Scandals over banks' bad behaviour, in areas such as price-fixing, money laundering and mis-selling continue to come to light.49 In other words, the real danger is not that things are simply "unchanged," but that the situation is now much worse. By delaying many of the more radical remedies that would help protect finance from itself, we have also simply delayed the day of reckoning: Central banks brought a global economic heart attack to an end by performing emergency surgery. But the patient has gone back to his old habits of smoking, heavy drinking and gorging on fatty foods. He may be looking healthy now. But the next attack could be even more severe and the medical techniques that worked a decade ago may not be successful a second time.50 Although the governmental response at the time almost certainly prevented a deeper depression from occurring, it can also be argued that insufficiently radical action was taken. This has subsequently led to additional social problems, such as rising income and wealth inequality, that have led some commentators to suggest that those activists looking to reform capitalism missed an opportunity to introduce real change: September 2008 was a near-death experience for global capitalism. At one point there were fears for the entire western banking system....The moment was ripe for politicians brave enough to state the obvious: that the crisis was the result of removing all the shackles on global financial capitalism put in place for good reason in the 1930s. But social democratic parties...were timid when they should have been brave, and have paid a heavy price as a result. Mainstream parties patched up the system and paid scant heed to the anger felt by those who felt ignored. The bitterness bubbled away and eventually found other ways of manifesting itself.51 The Financial Crisis continues to reverberate today, but in terms of consequences that range beyond the economic and into the political: In a democracy, the pitchfork-wielding masses will eventually make themselves heard. The story of American politics over the past decade is the story of how the forces Obama and Geithner failed to contain reshaped the world. The day-to-day drama of bank failures and bailouts eventually faded from the headlines. But the effects of the disruption never went away, unleashing partisan energies on the Left (Occupy Wall Street) and the Right (the Tea Party) that wiped out the political era that came before and ushered in a poisonous, polarizing one.52 The longer we leave this, the harder it is going to become, and the more painful the correction will be. In the meantime, the failure of capitalism to solve the underlying issue of the fair distribution of wealth across society has caused a vacuum that some are seeking to fill with more radical (and less effective) alternatives. The Rise of Socialism? The institutional response to the Financial Crisis has not lived up to many people's expectations. This is apparent in three areas in particular. First, the system remains largely unchanged. The banks are still too big to fail, and the CEOs of JP Morgan and Goldman Sachs, as well as others, still carry great weight"even after the post-crisis toughening of regulation, it is arguable that the big banks are so complex and lacking in transparency as to be unmanageable."53 As a result, finance is as dominant as ever. The stock market's daily performance is still reported at the end of every news broadcast, while a firm's stock price drives many operating decisions. As Rana Foroohar of Time puts it, "the business of America isn't business anymore, it's finance":54 Financiers in recent decades have made their money by focusing more on wealth creation through manipulating and timing markets rather than by lending and creating. Investors, asset managers, traders, and others have figured out how to craft financial products that can make money but that do not result in jobs or businesses.55 Second, few individuals were ever held to account for the widespread negligence and culpability that caused the Financial Crisis. Even though white-collar crime is notoriously difficult to prosecute, it is still astounding that of the 156 cases (criminal and civil) brought by the federal government since 2009 against the ten largest US banks, in 81% of those cases, individual employees were neither identified nor charged. A total of 47 bank employees were charged in relation to the cases. One was a boardroom-level executive....Of the 11 people who went to trial or a hearing and had a ruling in their case, six were found not liable or had the case dismissed. That left a total of five bank employees at any level against whom the government won a contested case.56 Third, the core problem, excessive personal debt, remains. What is frustrating is that while mortgages are now largely under control (with some worrying exceptions),57 a different debt has emergedone with the potential to inflame reactionary calls: [Today] mortgage borrowing, the culprit in countless crises through history, looks tame. But in its place a student debt bubble has inflated. Borrowing for higher education seems prudent, but then borrowing for a home was a no-brainer, too, until a decade ago. Student loans...can't be discharged in bankruptcy...which means they will haunt millions of borrowers for years to come.58 The combination of the system remaining unchanged, the lack of accountability, and the rise of student debt is combustible and leaves us exposed to future crises.59 There is widespread disaffection, particularly among younger, more vulnerable generations who see the mess and realize that they are going to have to clean it up.60 This is largely driven by feelings of injustice, as wealth and income inequality grow to alarming levels: In 1976 the richest 1 percent of Americans took home about 8.5 percent of our national income. Today they take home more than 20 percent. In major sectors of the economybanking, airlines, agriculture, pharmaceuticals, telecommunicationseconomic power is increasingly concentrated in a small number of companies.61 The result of all this is that people have "lost faith in the systemnot only in the banks and mortgage lenders, but in capitalism itself."62 This outcome has been building over many decades and multiple crises. In some ways, the Financial Crisis did not create new problems; it merely inflamed problems that were already there ("stagnant wages, widening inequality, anger about immigration and, above all, a deep distrust of elites and government").63 The result has been "a wave of nationalism, protectionism and populism in the West today."64 The key question, therefore, is whether these problems are an inevitable component of capitalism or whether they are a function of a distorted implementation of the current version. Either way, these frustrations have continued to grow, in both scale and scope, and suggest the need for some kind of change: And if you don't solve this problem, voters around the world have demonstrated that they're quite willing to destroy market mechanisms to get the security they crave. They will trash free trade, cut legal skilled immigration, attack modern finance and choose state-run corporatism over dynamic free market capitalism.65 In a 2017 opinion poll, "American millennials closely split on the question of what type of society they would prefer to live in: 44 percent picked a socialist country, 42 percent a capitalist one."66 This is startling, given the levels of wealth Western capitalist societies have created over the last century or so. Even more recently, Fortune Magazine declared that "when 65% of people under the age of 35 believe that socialism is a better model, we have a problem."67 And this concern is far from limited to the US: In Britain, less than one in five people agree with the statement that the next generation will be richer, safer and healthier than the last....Three-quarters of Britons now favour full nationalisation of all utilities and rail infrastructure. Asked to describe capitalism, people view it as "selfish," "greedy" and "corrupt."68 What is the effect of (1) the weakening of Western liberal democracy,69 (2) a loss of confidence in capitalism, and (3) the failure to distribute the benefits of globalization more equitably? One possibility is that people will begin to reconsider "the respective weighting...between the role of markets and government, between the invisible hand and the visible one."70 A likely outcome of this discussion will be that the demands placed on for-profit firms will shift in ways that favor the individual in the short term over the group in the long term. Along these lines, the specter of socialism is now being discussed as a solution to capitalism's worst failings. In the US, for example: Public support for socialism is growing....Membership in the Democratic Socialists of America, the largest socialist organization in the country, is skyrocketing, especially among young people.71 One problem with this narrative, however, is that the label "socialism" is thrown around a lot in US political debate, without much agreement over what it means: A recent Gallup poll showed that 57% of Democrats have positive views about socialism. But the poll never defined "socialism," so precisely what people were expressing support for remains unclear.72 Nevertheless, the concept of "woke business" has emerged. As the CEO of Levi's jeans, Chip Bergh, stated recently, "while taking a stand can be unpopular with some, doing nothing is no longer an option....Business has a critical role to play and a moral obligation to do something"a statement that the National Rifle Association labeled as "a particularly sad episode in the current surge in corporate virtue signaling."73 Yet the underlying shift in tone is tangible. Capitalism as we know it is under attack, and more is expected of firms as a result. The tenth anniversary of the Financial Crisis serves only to remind many of what went wrong, but also of what has yet to be fixed. Whether the substance of this critique and proposed solutions are more fanciful than realistic, it is up to business to defend the global economic system that has historically created so much wealth for so many.74 As noted in the Financial Times, "capitalism requires legitimacy. It would thrive over the long term only if it were seen to be on the side of the welfare of the nation's citizens."75 In beginning this progress toward reform, it is important to reinforce the point that capitalism cannot be "on the side" of anyone. It is a tool we have developed to structure society. As such, it will do what we want it to do. If we want to reduce inequality and redistribute wealth more equitably, then we can do that, but it takes stakeholder engagement to bring it about. Whether such policies would produce better outcomes is the subject of a hot debate that today can be traced back directly to the Financial Crisis. But it is important to state that capitalism is not the problem. If there is a problem, it is in the way capitalism has been implemented. As such, we can implement it differently, if we want to and are willing to engage sufficiently to make it happen. In short, "capitalism isn't the problem. Capitalism is the solution"76 within a strategic CSR framework. Questions to Be Addressed: 1. "The Occupy Wall Street campaign (http://occupywallst.org/) was a success." Do you agree or disagree? Why or why not? 2. After reading this case, what do you think were the main causes of the Financial Crisis? Has anything changed today? 3. How can a firm motivate salespeople who work on commission (as many mortgage brokers did in the run-up to the Financial Crisis) to sell products that are in their customers' interests rather than their own? 4. Consider how many credit cards you carry, and how many loans you've taken out. Do you think that reform of the credit-fueled economic model in the West is essential for a more equitable global economy? Questions to Be Addressed: 1. "The Occupy Wall Street campaign (http://occupywallst.org/) was a success." Do you agree or disagree? Why or why not? 2. After reading this case, what do you think were the main causes of the Financial Crisis? Has anything changed today? 3. How can a firm motivate salespeople who work on commission (as many mortgage brokers did in the run-up to the Financial Crisis) to sell products that are in their customers' interests rather than their own? 4. Consider how many credit cards you carry, and how many loans you've taken out. Do you think that reform of the credit-fueled economic model in the West is essential for a more equitable global economy?